Investors shouldn’t finance races to the bottom

I just read Albert Wenger’s post about profit destroying innovation and am left wondering if we are entering a period where startups are tearing down incumbents but won’t become sustainable companies in their own right. We have become very efficient at creating super fast growth companies with low or non-existent potential profitability from their existing revenue models. These are often marketplaces with 0% take (i.e. they don’t charge for listings or purchases) or SaaS companies giving away features that competitors charge for in the hope of charging for something else later.

As Bill Gurley wrote recently:

it is materially easier to take a company to substantial revenue if you generously relax the constraint of profitability. Customers will love you for giving away more value than you charge

The dangerous dynamic we should be avoiding is financing businesses to substantial revenues that won’t eventually generate significant profits. That’s happening increasingly often as late stage investors pay up handsomely for high growth businesses without clear/credible strategies for reaching positive cash flow. These un-profitable startups undermine the profitability across entire markets in a way that may not be recoverable. Albert Wenger’s said the same thing differently when he wrote the benefits of innovation are accruing to customers rather than providers. When that happens it is investors who foot the bill.